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My 3 Most-Often Recommended Annuities

Mature couple planning for retirement, Recommended Annuities

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Delaying when you take Social Security is, for all practical purposes, a U.S. Government annuity.

I've written in the past about avoiding annuities because of their high commissions and guarantees, which are complex and typically misunderstood. Let's delve deeper into what an annuity is, what it isn't and which ones may be worth your consideration.

Investopedia, a financial education website, defines an annuity as "a contractual financial product sold by financial institutions that is designed to accept and grow funds from an individual and then, upon annuitization, pay out a stream of payments to the individual at a later point in time. The period of time when an annuity is being funded and before payouts begin is referred to as the accumulation phase. Once payments commence, the contract is in the annuitization phase."

So the concept of growing money and then creating a steady stream of income to fund retirement is a great thing. If it can be done with low costs from a secure provider, I wholly support it. These three options often meet that criteria.

1. Delaying Social Security. Delaying when you take Social Security is like buying an inflation-adjusted cash flow that begins a few years later. For all practical purposes, it's a U.S. government annuity. For example, delaying payments from age 66 to 70 increases one's monthly benefit payment by 32 percent. That extra 32 percent also has an annual cost of living adjustment (COLA), so it, too, grows over time. In one example, I calculated that delaying Social Security four years would increase the payment by $987 a month. To get that additional monthly amount, the client would have to give up about $126,000 in benefit payments over those four years. However, to buy an inflation-adjusted monthly annuity of $987 beginning in four years would cost about $235,500 today for this 66-year-old man. Thus, this government annuity was priced 46 percent less than could be bought on the open market.

2. Employer pension (aka defined benefit plan). A large number of people have a pension decision to make at retirement. I've found that most government employees, and even a large number of those employed by private companies, have such a pension. Typically, the decision is whether to take a lump-sum payment (which can be rolled tax free to an IRA) or to take a monthly payment — often with survivor benefits. In many cases, part or all of the payments are guaranteed by the Pension Benefit Guarantee Corp. (PBGC). I compare the lump-sum payment to how much the recipient would have to pay to get a similar low-risk cash stream, such as by purchasing an annuity. About 75 percent of the time, I've found that taking the pension annuity payment is the superior choice.

3. TIAA traditional annuity. Over 3.7 million people mostly working for nonprofit organizations have retirement accounts at TIAA. One of the options to invest in is called the TIAA traditional annuity. Many participants (but not all) have access to a guaranteed 3 percent annual growth (accumulation) that also gives them either a lump-sum payment or an income stream in retirement that I've found to be at competitive rates. In actuality, rates over the past year have been higher than the 3 percent guarantee. With bank CDs and money-market funds paying so little, and the potential for bond mutual fund prices to decline if interest rates increase, I've often found this to be a great option for a client.

Perhaps that's why former Federal Reserve chairman Ben Bernanke has so much of his net worth in this particular type of annuity. The downside, however, is that the money is not backed by the U.S. government.

What these three annuities have in common is that no one has the incentive to sell them to you because they don't pay a sales commission. And because of that, the costs are lower — which is better for consumers. Two of the three are at least somewhat backed by the U.S. government, and the third, TIAA, has an AA+ rating by Standard & Poor's.

When it comes to investing, I never say never. If you have the ability to take advantage of any of these three "annuities," they are worth considering.

Allan Roth is the founder of Wealth Logic, an hourly based financial planning firm in Colorado Springs, Colo. He has taught investing and finance at universities and written for Money magazine, the Wall Street Journal and others. His contributions aren't meant to convey specific investment advice.

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